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Mervyn K. Lewis
Abstract
Islam commands authority over the totality of a Muslims being, not
accepting any distinction between the sacred and the secular. Economics,
politics, religious and social affairseven accountingfall under the jurisdiction of the divine law of Islamthe sharia. In fact, accounting in the
broad sense is central to Islam, since accountability to God and the community for all activities is paramount to a Muslims faith.
Based on the sharia, Islam has formulated a comprehensive ethic governing how business should be run, how accounting ought to be undertaken,
and how banking and nance is to be arranged. All of these components
pose unique challenges to Islamic accounting.
Introduction
The inuence of religion upon accounting is not an issue that has been
explored to a great extent in the conventional literature, although it is
easy to see how the two might be connected. Traditionally, religion has
had a role in shaping and enforcing ethical behaviour such as truthfulness, honesty, and justice. A community in which such values are paramount may be marked by a high degree of trust in business dealings
and nancial affairs. More generally, following Gray (1988), and Perera
(1989), culture has been recognised as a likely determinant of accounting, since culturedened by Hofstede (1994: 180) as the collective
programming of the mind which distinguishes the members of one
group from anothergoverns how individuals perceive their responsibilities and carry out their duties. If culture inuences accounting then
so surely does religion, if only because religion affects cultural values
(Hamid, Craig and Clarke 1993).
By and large, however, the Biblical injunction to render unto Caesar
the things which are Caesars, and unto God the things that are Gods,
has led to a divergence in the West between sacred and secular that is
anathema to Islam. In Islam, the realms of God and Caesar are one,
not separate jurisdictions, as allowed by Christianity.
Two aspects in particular shape the relationship between Islam and
accounting. One is that Islamic law, the sharia, claims to regulate all
aspects of life, ethical and social, and to encompass criminal as well as
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Lewis104
civil jurisdiction. Every act of believers must conform with Islamic law
and observe ethical standards derived from Islamic principles. Accountants, like any other adherent, must perform their duties in accordance
with the rules and regulations of Islam and base their actions on Islamic
ethical norms. These ethical principles dene what is true, fair and just,
the nature of corporate responsibilities, the priorities to society, along
with some specic accounting standards. Second, in addition to providing a set of business ethics, certain Islamic economic and nancial principles have a direct impact upon accounting practices and policies.
These principles include, most importantly, the institution of zakat (the
religious levy), and the prohibition of riba (usury) and the institution
of an interest free economic system.
This article examines rst the nature of Islam and Islamic law. It then
considers the implications for business ethics and accounting principles.
Finally, the paper outlines Islamic nancing rules and the signicant
ramications for accounting in Islamic nancial institutions.
Islamic law
Those who pioneered Islamic economic thought developed rules for carrying on commerce, banking and nance from Islamic law or the sharia
(formally sharia Islamiiah but generally abbreviated to shariah or
sharia). The literal meaning of the Arabic word sharia is the way to
the source of life and, in a technical sense, it is now used to refer to
a legal system in keeping with the code of behaviour called for by the
Holy Quran and the hadith (the authentic tradition). Muslims cannot,
in good faith, compartmentalise their behaviour into religious and secular dimensions, and their actions are always bound by the sharia.
Islamic law thus embodies an encompassing set of duties and practices
including worship, prayer, manners and morals, marriage, inheritance,
crime, and commercial transactions: that is, it embraces many aspects
that would not necessarily be considered as law elsewhere. It is thus
entirely religious, and as sacred law contains the core of Islamic faith
itself.
Islam is numerically the second-largest religion, with 1.2 billion followers (after Christianitys 2 billion), and follows the Judaeo-Christian
heritage as the third and last of the great monotheistic religions. One
who professes the faith of Islam is a Muslim. The origins of the word
Islam are in the root s-l-m which means tranquillity, peace (salam)
or to remain whole. The term aslama means to submit oneself with
complete peace of mind or to give oneself up to God, and it is from
this that the word Muslim derives. Frequently Islam is dened simply
as submission to God or surrender to God. Those who submit to
this path form the umma, the community of Muslims.
610 and 632 C.E. to the Prophet Muhammad ibn Abd Allah
. A work
roughly the same length as the New Testament, the Holy Quran calls
on polytheists (believers in many Gods), Jews and Christians alike to
commit themselves to Gods nal revealed message. The Holy Quran
is for Muslims in the most literal sense the word of God, and Islamic
law ows directly from it and is wholly inspired by it.
Islam, Christianity and Judaism are interlinked because all three are, in
reality, worshipping the same One God. Thus the God of Muslims is
the same God of the Jews and the Christians, although without what
perhaps might be seen as the racial exclusiveness attributed to Him by
Judaism, or the intricate theology woven around Him by Christianity
in the form of the Trinity. The Holy Quran teaches that God sent a
series of messengers and prophets culminating in the Prophet Muhammad
the last of the prophets, reviving and completing their message. Many
of the familiar stories and names of the Bible are to be found in the
Holy Quran.
Since Jesus Christ is the basis of Christian faith, it was sometimes
assumedquite incorrectlythat the Prophet Muhammad was to Islam
as Christ was to Christianity. Hence the old term Muhammadanism
wrongly given to Islam in the West until relatively recently. Although
for Muslims the Prophet Muhammad is insan-i-kamil, the perfect person, he is not divine, and is seen not as the founder of Islam, merely
When Muslims mention the Prophet Muhammad in speech or print, they usually
follow
the name with an expression in Arabic which can be translated, May the peace and
blessings
of Allah be upon him, sometimes written as pbuh, short for peace be upon him.
This
is not dissimilar to those Christians in earlier times who, when referring to a revered
forebear, would say may his or her soul rest in peace.
Lewis106
Sura (pl. surat) is a chapter of the Holy Quran. There are 114 suras of varying
length and
in all references to the Holy Quran (eg 30:39) the rst number refers to the sura
and the
second to the aya or verse.
.
Since Islamic law reects the will of God rather than the will of a human
lawmaker, it covers all areas of life and not simply those which are of
interest to a secular state or society. It is not limited to questions of
belief and religious practice, but also deals with criminal and constitution matters, as well as many other elds which in other societies
would be regarded as the concern of the secular authorities. In an
Islamic context there is no such thing as a separate secular authority
and secular law, since religion and state are one. Essentially, the Islamic
state as conceived by orthodox Muslims is a religious entity established
under divine law.
In practice, the position is more complex than this, as secular and sacred
co-exist and to some degree always have done. When Arab conquests
took place shortly after the death of the Prophet in lands formerly under
There are considerable doctrinal differences between the Shia and the four Sunni
schools
of Islamic law, in terms of who is permitted to interpret sharia law. Shiites believe
that
living religious scholars, known as mujtahids, have an equal right to interpret Divine
Law
as eminent jurists of the past, and their judgements replace the Sunni source of
deduction by
analogy from established law (qiyas). Shiism, which has various sub-sects, is
predominant in
Iran, and has signicant numbers of followers in Iraq, India and many of the Gulf
States.
Sunnis predominate elsewhere in the Muslim world and constitute over 90 percent
of all
Muslims.
Lewis108
behave and conduct their lives, and human actions are classied, in
descending order, as obligatory, meritorious, permissible, disliked and
forbidden. As such, the Holy Quran and the sunna are fully binding;
the other sources of authority are in one way or another justied by
reference to these two basic sources.
Shariaduties can be broadly divided into those that an individual owes
to God (ibadat, acts of devotion and ritual) and those owed to fellow
people, ie. what would constitute law in the Western sense (muamalat).
The former need not detail us, and include prayer, ablutions, fasting,
pilgrimage, the establishment of Mosques, observance of holy days, gestures and behaviour. Strict food laws forbid pork, blood, carrion, specify the method of preparing animals and ban the drinking of any
alcoholic beverages. Also prohibited is the representation of animals or
the human gure in art, as a precaution against any lapse into idolatry.
The other areas covered by Islamic law are considerable, and include
inter alia, marriage, divorce, sexual relations, care of children, adoption, maintenance, inheritance and so on, as well as commercial activities, to which we now turn.
Just as Islam regulates and inuences all other spheres of life, so it also
governs the conduct of business and commerce. Muslims ought to conduct their business activities in accordance with the requirements of
their religion to be fair, honest and just toward others. Rahman (1994)
notes that there are a large number of Islamic concepts and values which
dene the extent and nature of business activity. There are many positive values such as iqtisad (moderation), adl (justice), ihsan (kindness
par excellence), amanah (honesty), infaq (spending to meet social
obligations), sabr (patience) and istislah (public interest). Similarly,
there are a number of values which are negative, and thus to be avoided:
zulm (tyranny), bukhl (miserliness), hirs (greed), iktinaz (hoarding of
wealth) and israf (extravagance). Economic activity within the positive
parameters is halal (allowed and praiseworthy) and within the negative
parameters is haram (prohibited and blameworthy) which has to be
moderated. Production and distribution which are regulated by the
halal-haram code must adhere to the notion of adl (justice). Collectively, these values and concepts, along with the main injunctions of
the Holy Quran, provide a framework for a just business and commercial system.
Many verses in the Holy Quran encourage trade and commerce, and
the attitude of Islam is that there should be no impediment to honest
and legitimate trade and business, so that people earn a living, support
their families and give charity to those less fortunate. Nevertheless,
Muslims should not allow their business activities to dominate so that
making money becomes a rst priority and they neglect religious duties;
in particular, all trading must cease during the time of the Friday congregational prayer. Nor must the future be overlooked: upon death one
is expected to leave behind a family and descendants who perpetuate
the law of God, a permanent contribution which will benet the community, and a source of income for the poor and the needy and/or to
generate job opportunities for future generations.
Production
Distribution
Social responsibilities
Lewis110
Business principles
Property rights
Contract law
Business organisation
Shirkah al-inan
Musharaka.
Mudaraba or Qirad
stipulated for one of the partners and the other partner(s) are investors
Lewis112
who share the prots in return for the capital they have provided. The
dormant partner remains the owner of the capital, but takes no active
part in the enterprise.
There are two other principal categories of business enterprise. The rst
is a wage-rent enterprise, based onijara(hire), in which the person with
capital hires labour for a specic job or time and at a xed wage. The
nancier receives all prot and is responsible for all losses. Such an
enterprise may be arranged by a sole proprietor, or as a partnership
(shirkah).
The other main type of enterprise is, of course, the modern corporation.
Investments can be made in the stock market providing that the companies involved trade only in halal commodities. This is similar to the
modern Western idea of ethical investment. Under Islamic law it is lawful to own ordinary shares in companies, but is not lawful to hold preference shares.
Managerial ethics
Islamic accounting
Karim (1986), Adnan and Gafkin (1997), Askary and Clarke (1997),
Alam (1997) and Baydoun and Willett (1997), have adopted the rst
approach, and we follow them here.
Certain Islamic ethical principles have a direct impact on accounting
policy and principles. These principles include the interest free economic
system, the institution ofzakatand specic business methods, and these
are discussed later. In addition, the Holy Quran andsunna, upon which
ethical principles are derived, have dened clearly what is true, fair and
just, what are societys preferences and priorities, what are the corporate roles and responsibilities, and also, in some aspects, spell out specic
accounting standards for accounting practices.
Social accountability
In the Holy Quran, the word hesab is repeated more than eight times
in different verses (Askary and Clarke 1997). Hesab or account is the
root of accounting, and the references in the Holy Quran are to
account in its generic sense, relating to ones obligation to account
to God on all matters pertaining to human endeavour for which every
Muslim is accountable. All resources made available to individuals are
made so in the form of a trust. Individuals are trustees for what they
have been given by God in the form of goods, property and less tangible
assets. The extent to which individuals must use what is being
entrusted to them is specied in the sharia, and the success of individ-
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Full disclosure
Records
Believers, when you contract a debt for a xed period, put it in writing. Let a scribe write it down fairly . . . and let the debtor dictate, not
diminishing the sum he owes . . . (S2:282).
Islam thus provides general approval and guidelines for the recording
and reporting of transactions. Underpinning Islamic belief is the
requirement that doubt and uncertainty be removed from inter-personal
engagements. In business affairs, trading and the like, it clearly is evident that all parties rights and obligations are to be fully documented
for verication and exploration. Verses place an emphasis on recording
material credit loans and transactions, and advise that these transactions should be signed by debtors (to acknowledge their indebtedness
and the amount thereof), the ultimate in verication processes.
Materiality
Reliability
Askary and Clarke (1997) identify nineteen verses in the Holy Quran
placing emphasis on the reliability of matter.
aspect of Islamic secular life, reliability extends into the area of accounting. If published nancial information is unreliable, many followers will
be unable to accomplish their religious responsibilities, they will be
unable to assess their capacity to assist the disadvantaged, or their
capacity to pay zakat. If the managers of business entities are to be
honest to the business entities owners, Sura 4:58 indicates that they
must produce true and complete, reliable, nancial disclosure for them.
These verses place an emphasis on . . .to make over trusts to their
owners . . .. In other verses, there is an emphasis on the need to full
obligations.
Presentation
Reliable information must also be presented correctly and fully, including details of all the transactions undertaken. Sura 11:8485, for
example, says . . . give full measure . . .. True disclosure of nancial
facts, and the provision of them without any deceit or fraud in order to
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Periodicity
In order to conform with Islamic rules and norms, ve religious features, which are well established in the literature
, must be followed in
There are a large number of studies of Islamic banking and nance. For a recent
survey see
Riba
Perhaps the most far reaching and controversial aspect of Islamic economics, in terms of its implications from a Western accounting and
nancial perspective, is the prohibition of interest (riba). The payment
of riba and the taking of interest as occurs in a conventional banking
system is explicitly prohibited by the Holy Quran, and thus investors
must be compensated by other means.
The prohibition ofribais mentioned in four different verses in the Holy
Quran.
third enjoins Muslims to stay clear of interest for the sake of their own
welfare. The fourth establishes a clear distinction between interest and
trade, urging Muslims, rst, to take only the principal sum and second,
to forgo even this sum if the borrower is unable to repay. The ban on
interest is also cited in unequivocal terms in the hadith or sunna.
Although for most Muslims this clear prohibition is sufcient, the
Islamic ban on ribaliterally increase but widely understood in this
context to mean all predetermined interest payable on a loan of any
kindis well grounded in the Islamic theory of property rights. Islamic
law recognises two types of individual claim to property: (1) property
which is a result of the combination of an individuals creative labour
and natural resources, and (2) property the title of which has been
transferred by its owner as a result of exchange, remittance of the rights,
other benets, grants, and inheritance. Money represents the monetised
claims of its owner to property rights created. Lending money, in effect,
is a transfer of this right, and all that can be claimed in return is the
principal (Murvat, 1992). Funds are used either productively or unproductively. In the rst case, when funds are combined with creative labour, the lender may ask for a portion of the created wealth but may
not ask for a xed return, irrespective of the outcome of the enterprise.
In the second case, the money lent, even if legitimately acquired, cannot
claim any additional property rights, since none are created.
Surah al-Rum(chapter 30), verse 39; Surah al-Nisa (chapter 39), verse 161; Surah
al-Imran
(chapter 3), verses 1302; Surah al-Baqarah (chapter 2), verses 27581.
Lewis118
Zakat
According to the Holy Quran, God owns all wealth and private property is seen as a trust from God. Property has a social function in
Islam, and must be used for the benet of society. Moreover, there is
a divine duty to work. Social justice is the result of organising society
on Islamic social and legal precepts including employment of productive
labour and equal opportunities such that everyone can use all of their
abilities in work and gain just rewards from that work effort. Justice
and equality in Islam means that people should have equal opportunity
and does not imply that they should be equal either in poverty or in
riches (Chapra 1985). However, it is incumbent on the Islamic state to
guarantee a subsistence level to its citizens, in the form of a minimum
level of food, clothing, shelter, medical care and education (Holy
Quran 58: 11).
A mechanism for the redistribution of income and wealth is inherent
in Islam, so that every Muslim is guaranteed a fair standard of living,
nisab. Zakat is the most important instrument for the redistribution of
wealth. This almsgiving is a compulsory levy, and constitutes one of
the ve basic tenets of Islam. The generally accepted amount of the
zakat is a one fortieth (2.5 percent) assessment on assets held for a full
year (after a small initial exclusion, nisab), the purpose of which is to
transfer income from the wealthy to the needy. Consequently, in countries where zakat is not collected by the state, every Islamic bank or
nancial institution has to establish azakatfund for collecting the funds
and distributing them exclusively to the poor directly or through other
religious institutions. This religious levy is applied to the initial capital
of the bank, on the reserves, and on the prots while the major social
purpose is to moderate social variances in Islamic society, and to enable
the poor to lead a normal, spiritual and material life in dignity and contentment.
The signicance of zakat in Islam is different from a welfare programme, and zakat is different from a tax as it is understood today. A
tax in a modern society is an obligation of individuals and other entities
toward the state, whereas zakat is an obligation of a Muslim not only
to society and the state, but also to Allah. In other words zakat is not
merely a contribution, but it is also a due or a claim. A person
paying zakat is not primarily doing a favour to the recipient or beneciary of zakat , but is rather meeting a claim on himself by purifying
wealth. Of course, the same is true of a Muslim who eschews interest.
Neither obligation can be judged in earthly terms alone.
Haram
Gharar/Maysir
elements of speculation,gharar(literally hazard). Whileribaandmaysir are condemned in the Holy Quran, condemnation of gharar is supported by ahadith. In business terms, gharar means to undertake a venture blindly without sufcient knowledge or to undertake an excessively
risky transaction. By failing or neglecting to dene any of the essential
pillars of contract relating to the consideration or measure of the object,
the parties undertake a risk which is not indispensable for them. This
kind of risk was deemed unacceptable and tantamount to speculation
due to its inherent uncertainty. Speculative transactions with these
characteristics are therefore prohibited. Gharar applies also for investments such as trading in futures on the stock market; indeed, gharar is
present in all future (mudhaf) sales. Such a contract is null and void.
Takaful
Lewis120
This rejection of interest poses the question of what replaces the interest
rate mechanism in an Islamic framework. If the paying and receiving of
interest is prohibited, how do Islamic banks operate? Here partnership
nancing arrangements come in, substituting prot- and loss-sharing
for interest as a method of resource allocation. Although a large number
of different contracts feature in Islamic nancing, certain types of transaction are central: trustee nance (mudaraba); equity participation
(musharaka); and mark-up methods. Mudaraba is a prot and risk
sharing contract where one party entrusts funds to an investor in return
for a predetermined share in the prot/loss outcome of the project concerned. This principle lies at the heart of the system of Islamic banking
since most funds are provided to an Islamic bank under such investment
arrangements. Under musharaka, on the other hand, there is usually
more than one single contributor of funds; all of the parties invest in
varying proportions and the prots or the losses are shared according
to their contributions in the project. The musharaka involves a more
active partnership between entities who pool their capital and manage
and control the enterprise together, with prots and losses divided
amongst them according to prearranged ratio. When we add to these
two the idea of mark-up, for which there are a great number of variants, where assets and other items are acquired for later re-sale or lease
Investment accounts
The balance sheet status of investment accounts provides the rst challenge to Islamic accounting. Depositors funds can be placed either on
anal-wadia(custody, safekeeping) basis or under themudaraba(trustee
nance) principle in an investment account where the bank invests the
funds on behalf of the depositors and shares the prots according to a
pre-agreed prot-sharing ratio. Most funds (over 90 percent in most
cases) are deposited into investment accounts. Some banks include such
funds on their balance sheet while others show them off-the-balancesheet as funds under management, much as an investment bank would
do. As well as local regulatory requirements, the choice is governed by
whether funds are at the clients risk or co-mingled with those of the
bank, and whether investment is restricted or unrestricted.
However, these sources of differentiation raise the more fundamental
issue of the status of investment account depositors vis-a`-vis shareholders. Under the trustee arrangement for investment accounts, depositors act as nanciers by providing funds, and the bank acts as an
entrepreneur by accepting them. Neither the nominal capital value nor
a pre-determined rate of return on deposits is guaranteed. Depositors
effectively become shareholders. If the bank makes prots then the
shareholder-depositor would be entitled to receive a certain proportion
of these prots. On the other hand, if the bank incurs losses the deposi-
Lewis122
own any portion of the banks equity capital, and under the mudaraba
contract cannot inuence the banks investment policy.
An Islamic banking system, in short, is essentially an equity-based system in which depositors are treated as if they were shareholders of the
bank, as some writers have argued (eg Khan M S 1986; Al-Harran
1993). However, they are a very special type of shareholder. In effect,
they are non-voting shareholders. Normally, someone with ownership
rights in a company can express their disappointment with the companys performance by either getting rid of their shares or in some way
expressing their concern. Hirschman (1970) called this the dichotomy
between exit and voice. Expressed in these terms, the Islamic depositor cum non-voting shareholder has little exit and no voice.
Because of the lack of protection for investment depositors (in the form
of deposit insurance, for example), Islamic bank depositors have more
incentives to monitor bank performance than conventional depositors.
Information disclosure should be more important in an Islamic banking
environment as a result of this special agency problem (Archer and
Abid 1996). This feature, in turn, places a special responsibility on the
adequacy of Islamic accounting procedures.
Prot distribution
Accounting concepts
Compounding these ambiguities, there is the question of the compatibility of various accounting principles with the Islamic point of view.
A number of concepts such as conservatism (using the lowest values
of assets and the highest values of expenses, or reporting expenses
sooner than later and recognising revenues later than sooner) and mat-
Social activities
Sunni legal doctrine has four main schools, each with its own system of theory and
applications of law, although each recognises the legitimacy of all of the others. The four
orthodox schools are the Hana (rationalist), the Maliki (traditionalist), the Hanbali
(fundamentalist) and the Shai (moderate). The Hana school is followed by the
majority
of sunni Muslims in Lebanon, Iraq, Syria, Turkey, Afghanistan, Pakistan, Bangladesh
and
in different places in India. The Moors who ruled Spain were followers of the Maliki
school
which, nowadays, is found mostly in Africa. The Hanbali school is predominant in
Saudi
Arabia. Followers of the Shai school today are found extensively in South East Asia.
Lewis124
Conclusion
The rst duty of a Muslim is to serve God (Allah) in all facets of life
since Islam does not recognise a division between secular and sacred
activities. Accounting, if performed in accordance with Islamic law (the
sharia), should be as much an act of worship as prayer. By contrast,
Lewis126
and auditing controls in order to satisfy both the religious auditors and
the external ones. Again, this need to sustain a unique and comprehensive form of ethical investments has no counterpart in conventional
banking.
References